Bullishness by the numbers

Commentary: Stock volume has triggered 3 rare technical events

ANNANDALE, Va. (MarketWatch) -- A number of the technically-oriented newsletter editors I monitor have noted that volume during the stock market's rally over the last couple of weeks has been anemic.

They say that they would be more enthusiastic if volume during this rally had been as high, or higher, than it had been during the panic-stricken decline that preceded the rally.

And no doubt they have a point. But there is one aspect of the volume during the stock market's recent rally that is quite bullish: On three of the past dozen trading sessions, stock market volume triggered a bullish technical signal known as a "Nine To One Up Day."

This signal is based on the volume of all New York Stock Exchange-listed stocks that go up on a given day, expressed as a percentage of the total volume of all stocks that rose or fell on that day. On a day when rising stocks' volume is the same as declining stocks' volume, for example, this ratio would be exactly 50%.

A "Nine To One Up Day" occurs when this ratio is 90% or higher. According to Martin Zweig, who helped to develop this indicator several decades ago, such a huge imbalance of up volume over down volume "is a significant sign of positive momentum. In other words, when daily up volume leads down volume by a ratio of 9-to-1 or more, that tends to be an important signal for stocks." The quotation comes from Zweig's 1986 book, "Winning on Wall Street."

I am familiar with Zweig's research because, until the mid 1990s when he discontinued them, he used to publish two investment newsletters. Both letters were ahead of the stock market averages at the time they were discontinued, according to the Hulbert Financial Digest.

Paul Desmond is another newsletter editor who has done extensive research on the significance of trading sessions with big imbalances of upside or downside volume. He is the editor of Lowry On Demand Investor, another newsletter that the Hulbert Financial Digest tracks.

How bullish are 9-to-1 up days? Zweig in his book argues that, "Every bull market in history, and many good intermediate advances, have been launched with a buying stampede that included one or more 9-to-1 up days."

A 9-to-1 up day was turned in on Aug. 17, Aug. 29 and Aug. 31.

These second and third 9-to-1 up days add greatly to the bullish significance of the first, according to Zweig. That's because a single 9-to-1 up day, by itself, has not always been a bullish event. In his 1986 book, Zweig therefore argued that it would be better to focus on occasions in which two such days occur relatively close to each other .Zweig used a three-month window.

Zweig called these "double 9-to-1 signals." And with what happened Friday, we actually have a "triple" 9-to-1 signal.

To be sure, the volume story is not uniformly this bullish. For example, there have been several 9-to-1 down days since the market correction began on July 19. According to Zweig, a 9-to-1 down day in the proximity of two 9-to-1 up days implies "not as much (upward) thrust" as do two 9-to-1 up days that are unaccompanied by a 9-to-1 down day.

Nevertheless, Zweig wrote that the stock market's average return is still above-average following double 9-to-1 days that are accompanied by 9-to-1 down days. "The record (for such days still) provides great comfort to the bulls," as he put it in his book.

This comfort is confirmed by statistical tests conducted by David Aronson, an adjunct professor of finance at Baruch College. Aronson is the author of "Evidence-Based Technical Analysis," in which he discusses how to use the "scientific method and statistical inference" in judging investment strategies.

Aronson, along with the students in a class he teaches at Baruch, tested the statistical basis for Zweig's confidence in double 9-to-1 signals. They did not differentiate between such signals that were accompanied by intervening 9-to-1 down days and signals that were not.

r Aronson told me that he and his "class used data from the beginning 1942 through fall of 2006, and we looked at what happens in the stock market in the 60-trading-day period following a Zweig double 9-to-1 signal, versus what happens the rest of the time. In those 60-trading-day windows, the S&P 500 index
SPX, -1.66%
produced an average annualized return of over 22%, on the assumption that an investor entered the market on the close the day after a double 9-to-1 signal was triggered and held until the end of the 60th trading day later. In the non-signal periods, in contrast, the return averaged 4.5% annualized. The difference between these two average returns is statistically significant." Aronson told me that these calculations do not include dividends.

The last time a double 9-to-1 signal was triggered was on March 21. An investor who bought the S&P 500 at the close on March 22 and held for 60 trading days realized an annualized gain of 31%.

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